If a bank lends at 10% but requires a 12% compensating balance, what is the effective interest rate on the loan?
A)10.0%
B)10.8%
C)11.4%
D)12.0%
E)12.6%

Question

Quizplus · Accepted Answer

The effective interest rate is 11.4% because the bank requires a 12% compensating balance, which means that the borrower can only use 88% of the loan proceeds. The effective interest rate is calculated as the annual interest rate divided by the percentage of the loan proceeds that the borrower can use. In this case, the effective interest rate is 10% / 0.88 = 11.4%.

If a Bank Lends at 10% but Requires a 12